More Accounting Deficiencies Linked to Inventory

Taxes have long been a top accounting bugaboo, but keep an eye on the inventory.

Large companies disclosed deficiencies in their procedures to account for inventory, vendors and cost of sales 38 times last year, putting the category just behind tax. In 2012, inventory ranked third on the list and was sixth as recently as 2011, according to Audit Analytics.

So far this year there have been six disclosures that inventory accounting procedures are inadequate, putting it atop the list of issues. But such disclosures are made in companies’ annual reports, most of which won’t be filed until early next year.

The problem is that companies have broad latitude in calculating inventory on their balance sheets. For example, companies must decide whether to value their inventories at replacement cost, retail value or at a discount.

The proliferation of inventory accounting deficiencies could be self-fulfilling, said Don Whalen, director of research for Audit Analytics. When a problem arises at one company, auditors will survey their clients for similar lapses.

Such disclosures are required under a section of the Sarbanes-Oxley financial reforms that took effect in 2004. Reporting a deficiency doesn’t necessarily mean a company has to restate results, but does flag that it can’t ensure accuracy.

Inventory accounting has become so complicated that the Financial Accounting Standards Board has proposed simplifying procedures. FASB, which sets accounting rules for U.S. companies, said it has fielded complaints that the process is “unnecessarily complex because there are several potential outcomes.”

The public has until Sept. 30 to comment on the proposed changes. The FASB is expected to deliberate the matter further.

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